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OPEC Discord Sends Oil Prices Lower -- Update

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Oil prices fell on Tuesday, with market participants unconvinced that OPEC will reach a deal to cut production, anticipation of which that has boosted the crude market in recent weeks.

The January contract for Brent, the global crude benchmark, was down 1.89% at $48.28 a barrel while its U.S. counterpart West Texas Intermediate fell 1.85% to $46.21.

In September, OPEC agreed on targets that would have translated into production cuts of 200,000 to 700,000 barrels a day. Analysts say if the Wednesday meeting ends inconclusively, oil prices could fall as low as $35 a barrel.The crude market is being driven by headlines, so analysts predict that the oil price will stay volatile this week, no matter what the Organization of the Petroleum Exporting Countries decides at the summit.

Oil prices edged up overnight after Iran and Iraq signaled they were willing to hold output steady. Both countries had previously said they wanted to increase output.

Germany's Commerzbank said that the market's "hopes and fears" were continuing to drive price fluctuations and that prices are holding up surprisingly well considering that OPEC delegates at Monday's preliminary meeting left without reaching an agreement.

The bank added that the main hurdle was Saudi Arabia's insistence that Iran caps production at 3.7 million barrels a day. Tehran is insisting on a cut of around 3.97 million b/d.

Most observers agree that Saudi Arabia does want a swift resolution, but Iran will likely wait until the formal meeting isunder way before the country's negotiators show their hand.

Whatever Iran's motives, Olivier Jakob, at Switzerland-based Petromatrix, believes that the delay is helping Russia avoid agreeing to any production freeze before the formal meeting gets under way.

"Saudi Arabia would probably have liked an early agreement before the meeting in order to present a special combo package of an OPEC cut and a freeze from Russia," Mr. Jakob said. "It is interesting to note that the Russian and the Iranian president made public that they held a phone conversation yesterday to discuss, among other things, the OPEC meeting."

One of the key hurdles for the production accord is Russia, which isn't a member of OPEC. Russia has indicated it is only interested in holding production at 11.2 million barrels a day. A freeze, it said, is essentially a reduction because it planned to increase output next year.

OPEC will also struggle to nail downproduction quotas for member nations as several countries--such as Nigeria and Libya--have requested exemptions because their oil production and exports have been hurt by militant attacks. In addition, OPEC doesn't have the authority to make members comply with their production assignments.

If OPEC decides to abandon its pledge to cut output, oil prices will be hit hard in the short-term, falling to around $40 b/d, analysts say. However, Bjarne Schieldrop, from SEB bank, said that the market was likely to shrug off the setback and oil will likely trade back to around $48 a barrel by the end of 2016.

"Higher oil prices means non-OPEC producers will be more encouraged to drill for more oil, which will increase global supply and prices will be depressed again," said Gao Jian, an energy analyst at SCI International.

In the U.S., where many oil producers were forced out of the market when prices dropped below $40 a barrel, there aresigns of resilience. The latest forecasts from the U.S. Energy Department show domestic crude production is likely to hit 8.7 million barrels a day in 2017, which is 100,000 barrels a day higher than the previous estimate.

Production elsewhere is also climbing. North Sea producers, who have been troubled by rising costs and high taxes, recently increased output to a three-year high. That shows that any OPEC agreement would have a limited impact on the global crude glut, said Hamza Khan, head of commodity strategy at ING Bank.

"The whole concept is so silly," Mr. Khan added. "If one part of the world cuts, supply will come online in other parts of the world...and it will come on very quickly."

Market players will also focus on the weekly U.S. inventory forecast from the American Petroleum Institute Tuesday, ahead of Wednesday's official data from the Energy Information Administration. With OPEC hogging the headlines, though, trading around the U.S. statements is likely to be less active this week.